Sunday, May 25, 2008

Deal or Bust?

I think this report from Kara sounds most credible so far compared to so many others before this. I really believe that this is a game of chess between the Emperor (Bill Gates) and the Princes (Google boys). Ballmer and Yahoo guys are just pawns and other pieces in this game. The decision to walk when the deal seemed so close was not typical Ballmer and had all the finger-prints of someone who is a great strategist like Gates. But MSFT is in a precarious position, because either strategy (buying or walking) can lead to a sharp and significant drop in its future value and clout. Without the potential deal from GOOG, Yang wouldn't have been able to defend the castle for long. I don't think GOOG will leave any stone unturned to defend their search cash-cow from MSFT, even if they have to do a "live cash-back style" deal with YHOO, where they make nothing and pass on all the benefit to YHOO. In that case it would be difficult for DOJ to do anything, because its a case of no.1 helping no.2 rather than hurting it by doing something anti-competitive. Also joeblow's "boats that float" argument would float as well.

Icahn and other corporate raiders are just opportunists who see an ideal arbitrage opportunity with very limited downside. They must really believe that YHOO's potential value is in the $30-35, regardless of whether MSFT buys them or they sign an ad deal with GOOG. That's the reason that they have bought substantial stakes. The strongest justification is that YHOO is the only strategic imperative for MSFT for getting the scale that they desperately need. So even if they walk again, it doesn't preclude them from returning to the table again, which should support YHOO stock in that scenario. Also Icahn bought options dated 2010, which means he is not concerned about the timing of the deal and is prepared to hold longer term if there is a delay in the resolution. Another reason might be that he doesn't believe a deal is going to get done within couple of months, and so decided to go longer term.

I also agree with the "weekend or bust" aspect of the current status of the deal because the sooner YHOO signs up with GOOG, sooner they can derive the financial benefits, which will improve their position in the proxy fight, which is likely to be after the earnings report for the current quarter. They are perhaps waiting for the categorical statement from MSFT, that they have "REALLY" moved on and are not interested in any kind of deal with YHOO. If MSFT issues this kind of statement soon, then YHOO will immediately sign up with GOOG and support its stock. If MSFT doesn't issue such a statement, then the status quo may continue for some more time as there is no urgency for YHOO to sign up with GOOG. However considering the beating that MSFT stock has taken since the day this deal was announced in end of Jan, and it seems to be getting worse, the pressure is on MSFT to make a final statement on the deal and prevent any further drop in its value. I'm sure the walksters are hoping for this as well. The stock market hates uncertainty more than anything else.

The odds above seem about right, except for the price I think. I expect the price to be around ~$35 with a significant component of value guarantee, if indeed MSFT and YHOO agree to a full acquisition. I guess its obvious that this is the worst nightmare for the walksters. It may also be perceived as negative by some of the trigger-happy GOOGsters, although long-term it would be great for GOOG because MSFT and YHOO together would sink much faster in the online waters due to the additional momentum and weight. The deal would be accretive in that sense. :-)

I never put any faith in MSFT's attempts to do a partial deal with YHOO, because if it was so difficult to come to terms on a full acquisition, imagine the difficulty of doing a partial deal. I think this was just a delaying tactic by MSFT to buy some more time, no matter what the sources say. Its much easier to do partial deals with willing partners. That's the reason its more likely with GOOG.

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